12/05/2017

The Economist buys into Hart and Zingales' Proposal to Boost Shareholder Democracy

ANGLO-SAXON capitalism has had a bad decade. It is accused of stoking inequality and financial instability. A relentless pursuit of shareholder value has led big firms to act in ways that often seem to make the world a worse place. Aeroplane seats get smaller, energy firms pollute the air, multinationals outsource jobs and Silicon Valley firms avoid tax. Some people think that governments should exert more control over private enterprise. But what if the answer to a deficit of corporate legitimacy was to give shareholders even more—not less—power?

That is the intriguing possibility raised by a new paper by Oliver Hart of Harvard University and Luigi Zingales of the University of Chicago. Their argument has two parts. First, the concept of shareholder capitalism should be expanded, so that firms seek to maximise shareholders’ welfare, not just their wealth. Second, technology might allow firms to make a deeper effort to discover what their true owners want. Over 100m Americans invest in the stockmarket, either directly or through funds. It is their money at stake, but their views and values are often ignored. ...

The authors envision shareholders guiding the broad direction of company strategy. They do not elaborate on the details, but imagine 100m Americans pressing a “shareholder democracy” app on their phones. Grannies from Grand Rapids and cowboys from Colorado might vote for Delta Air Lines to provide more legroom, Exxon to assume a higher carbon price when it drills for oil, IBM to move some jobs from Delhi to Detroit and Apple to pay a higher tax rate than its current 18%.

My mentor Michael Dooley once observed of employee participation in corporate democracy that workers will be indifferent to most corporate decisions that do not bear directly on working conditions and benefits: “As to the majority of managerial policies concerning, for example, dividend and investment policies, product development, and the like, the typical employee has a much interest and as much to offer as the typical purchaser of light bulbs.” Michael P. Dooley, European Proposals for Worker Information and Codetermination: An American Comment, in Harmonization of the Laws in the European Communities: products Liability, Conflict of Laws, and Corporation Law 126, 129 (Peter E. Herzog ed. 1983). The same is obviously true of so-called ordinary shareholders. The idea that such shareholders know better than management how wide Delta's seats should be is patently absurd.

There's no reason to think that even supposedly sophisticated investors such as hedge funds would be better at making operational; or strategic decisions for corporations, as I explained in Preserving Director Primacy by Managing Shareholder Interventions (August 27, 2013). Available at SSRN: https://ssrn.com/abstract=2298415:

As Professor Lawrence Mitchell (2009) asks:

Do we really want speculators telling corporate boards how to manage their businesses? Those who say “yes” want to increase short-term management pressure and thus share prices, regardless of the corporate mutilation this induces. They do not seem to care that their profits come at the expense of future generations’ economic well-being. But if our goal is to give expert managers the time necessary to create long-term, sustainable, and innovative businesses, the answer is a clear “no.”

Mitchell’s argument is supported by empirical studies finding that it is difficult to establish a causal relationship between improved firm performance, if any, and business strategy changes effected at companies targeted by shareholder activists. (Gillian & Starks 2007, 69)

Mitchell’s argument also finds support in Brian Cheffin’s finding that, except for “a few hedge funds,” institutional shareholders “were largely mute as share prices fell.” (Cheffins 2009, 3) Even in the U.K., where shareholders already possess more governance powers than do shareholders of U.S. firms, big institutional investors simply stood by as the crisis unfolded. (Cheffins 2010) Strikingly, however, directors of troubled firms commonly played an active role in responding to the crisis, as evidenced by their orchestration of CEO turnover at a rate far exceeding the norm in public companies. (Cheffins 2009, 39-40)

The problem with plebiscitary shareholder democracy becomes even more obvious when the decision tree becomes more complex than a mere binary choice. Consider the idea that shareholder might vote on whether Exxon should "assume a higher carbon price when it drills for oil." That initial decision requires a host of subsidiary decisions, ratcheting up the complexity of the problem. For example, should carbon emissions resulting from traditional drilling be treated differently than those resulting from fracking? Should carbon resulting from natural gas drilling be treated differently than that resulting from drilling for oil? How much higher should the assumed assumed price be set?

The Economist acknowledges some of these concerns, but just sweeps them under the table. That dog won't hunt.